There were two accounting policies used by AOL that were considered aggressive, as well as controversial. The first was to amortize its software development costs and the second was to capitalize subscriber acquisition costs.
The lifetime, for amortization purposes, which AOL assigned to software development costs was five years. This was considered by many to be an exceptionally long time considering the pace at which technology was progressing during that period of time. However, none of the regulatory or advisory agencies had established an absolute useful life designation, and the only available reference point at that time was the FASB Statement #86 of August 1985. It established that costs for internally developed software could be capitalized only from the point of “technological feasibility”, and therefore all planning, designing, coding and testing should be expensed. It further stated that the capitalization costs “could be amortized for up to 60 months”. It seems that AOL may have used Statement #86 to determine its amortization period.
The second accounting policy termed overly aggressive was AOL’s capitalization of subscriber acquisition costs. These were costs associated with actually enticing and enrolling new customers into AOL’s program and were for direct mail, advertising, and start-up kits. The only advertising/marketing costs AOL did expense were the amounts relating to the free first ten hours that was given to each new subscriber. The amortization period for the expenses of the direct marketing programs was twelve months. Also included in capitalization, but with an eighteen month amortization period, were so-called “bundling costs” for co-marketing efforts with magazine publishers and PC producers. These time frames for amortization were well known in the industry, even if they were controversial. But then in July 1995, the periods for both marketing categories were increased to 24 months, and that generated questions from industry analysts, which in turn forced AOL into a defensive position.
The rationale presented was that AOL was continuing to follow the same standard accounting practice as in previous years by matching the subscriber acquisition costs (SAC) to revenue receipts which would be generated over several years. According to CFO Lennert Leader, both the software development expenses and the SACs produced customer accounts that lasted a long time. Leader said the new projected average life of an AOL account was 41 months, up from a previous 25 months in 1992, hence the increased amortization periods were justified.
There may be some validity to the given explanation. At the time, AOL discs seemed to proliferate by the thousands. They would come in the mail addressed to Resident, and they were on the counter as freebies at the market, the drugstore and the hairdresser. Friends gave them to friends after receiving a second or third copy. After a while, you would just throw them away because you could only get one free 10 hour subscription. So there was no true way to determine how many discs were actually generating new customers. Bottom line, the explanation doesn’t hold water, and it sure doesn’t make it ok to have capitalized those expenses.
The 4th quarter 2002 report for AOL TIME WARNER had a one-time charge of $45.538 billion for impairment of goodwill. Of that, $33.489 billion was attributed to AOL’s lower than expected performance, including the continued decline in the online advertising market. This write down was in addition to the 1st quarter goodwill impairment charge of $54 billion. Both of these write downs resulted from the implementation of FAS142 which required annual testing of impairment to goodwill (and other intangible assets) instead of annual amortization. The 4th quarter 2008 report for AOL TIME WARNER had a one-time charge of $2.207 billion again for impairment of goodwill in the AOL segment. The...